Martijn Wilder, Peter Vis and Chris James

May 2005's Viewpoint focuses on the opportunities and challenges associated with emissions trading. We have spoken to three international experts on the subject.

What are the advantages of emissions trading as a way to reduce CO2 emissions?

Martijn Wilder (MW): Market based mechanisms are a legal compliance tool, designed to achieve an outcome in the most efficient manner. With trading, rather than saying, you must reduce emissions and you must pay the cost to do so, you are saying, you must reduce emissions but it is up to you if it's more cost effective to buy or sell - so it gives you more flexibility. But it is just one tool in a mix of policy responses.

Peter Vis (PV): The biggest advantage for me is that emissions trading makes reducing emissions cheaper and by doing so it makes the willingness to act stronger. Let's say the cheaper it is, the more people are going to be willing to reduce. We've got so much that people need to reduce over the coming decades that any other way than the cheapest way won't persuade people of the need.

Chris James (CJ): We have had a lot of experience in the US with emissions trading - through NOx and SOx trading schemes. These systems have successfully shown that having a robust trading program enables you to achieve deeper reductions for less overall cost than more traditional command and control structures.

What do think is the percentage of overall emissions that can be tackled through emissions trading?

PV: Projections are difficult to make. Right now, the greenhouse gas emissions trading that has started in Europe covers 45% of the EU's CO2 emissions and about 33% of its global greenhouse gas emissions (all the greenhouse gases put together). We are trying to use the principle whereby you concentrate the sources of these emissions which are going to make the biggest contribution towards the attainment of the targets. How much emissions trading could cover, rather depends. I think it can cover more, it can certainly cover other greenhouse gases and it can cover other industrial installations. But I'm very much of the view that you shouldn't be trying to add on thousands of additional sources of emissions for very little extra coverage because of the law of diminishing returns. It would be simpler to apply other kinds of measures for smaller sources. What I am saying really is that emissions trading is a very useful instrument but it is not a panacea. You can't just envisage the whole world and all sources engaging in emissions trading. I think that would be naive and indeed it might even be dangerous because emissions trading can be messed up, as it were, by undue complexity, monitoring difficulties and uncertainties.

CJ: Under RGGI, we are looking first at electric generating units. We have the most robust data for those larger units as they have been required to monitor CO2 by the Clean Air Act since the early 1990s. The electricity generating sector makes up around a quarter of the Northeast states' current emissions - and a much larger fraction could be encompassed if you also included indirect emissions from electricity (industrial, residential and commercial sources). Transport could also be included under emissions trading if you looked at it in terms of large corporate fleets, airports etc. Whatever we do we need to make sure that the system is open enough to accommodate other sectors.

What do you see as the strongest other policy measures that can be a good match with emissions trading?

PV: In the EU we have debated what measures might be used we have proposed various options. To give you some examples:

In the 1990's, the Union proposed a CO2 energy tax, which in effect applied a cost on every ton of CO2 emitted. That's one option that still exists and is used in some countries.

Another approach is setting what we call Emission Limit Values. They are limits to how much can be emitted. They are defined in concentrations by volume of flue gas. The Integrated Pollution Prevention and Control (IPPC) Directive, for example, would allow a member state to fix these emissions and values for a particular installation. But of course if you are going to fix emission limits and you are not going to allow there to be any trading, you are going to be saying to the company you don't have the choice of buying extra allowances from someone who has reduced their emissions. You've got to do it yourself whatever the cost.

And then there's voluntary agreements. There is a voluntary agreement with European car manufacturers which has agreed standards of energy efficiency for new cars produced and sold in Europe and this is complemented by an agreement with the Japanese and Korean car manufacturers. So this is a voluntary agreement whereby over a period of about 10 years, the companies have committed to improve the energy efficiency of the cars that they sell. That's a good thing - we are interested in results, we're not interested in how. But we wouldn't necessarily be able to secure these voluntary agreements in all other sectors.

CJ: A number of the Northeast states have adopted the California Low Emission Vehicle (LEV) programme, and are also working on the Pavley amendments to those regulations, which further control greenhouse gas emissions, and are an important step toward reducing emissions from the transportation sector.

Are there any real disadvantages of emissions trading as a way of reducing emissions?

MW: Not really. There are administrative burdens, but if you keep it simple and manage it properly, these can be minimised. I think the greatest challenge in emissions trading is the politics in designing the scheme, the politics in deciding who is allocated what etc. Also, emissions trading cannot easily be applied to all sectors such as transport. Although air travel is easier because of the large volumes of emissions from each airline, it is much more difficult with individual cars, which are a significant and growing problem.

PV: Disadvantages of emissions trading, well, I think there aren't a lot of course. What I think we do have to acknowledge is that there is a cost of reducing greenhouse gas emissions in the EU and because emissions trading is trying to achieve just that, there are going to be costs for companies covered by the scheme as a whole. But it is very important to understand that these costs are lower costs than they would be if we were still trying to achieve the same environmental targets without an instrument like emissions trading.

An important lesson we've learnt is that you can't allocate in a way that keeps everybody happy and at the same time contributes to achieving climate change objectives. We must accept that there is something of a trade off between simplification and transparency on the one hand and fairness on the other.

CJ: Defining the boundaries of the trading regime is certainly a challenge. Our regime only covers the Northeast US states, and currently we are not looking at ways to expand that to other regions. So there is a possibility that some of the more efficient, cleaner generated electricity from states included in the scheme could be displaced by dirtier, less efficient electricity feeding into the grid from states outside the boundary. Unless we also have ancillary policies on energy efficiency and transmission infrastructure, leakage could be a big problem on imports, and could detract from the emission reductions achieved through regional trading. We want to ensure that the boundaries can be expanded and/or that at the same time we introduce complimentary energy policies that help address the import issue.

Another disadvantage could be the issue of currency. Whatever kind of programme is developed, we would want to make sure that the currency used could be tradable in the open market - so that one ton of carbon in the Northeast US states is worth the same as a ton of carbon in Canada, the EU, or the UK. We really want to help establish a price signal, and having that type of design up front will help promote a better market for trading overall.

There is also the situation where each state is much like a member state in the EU - a sovereign state, subject to its own processes and regulations. So the same sort or dynamics are in play here where you will have, just by the nature of the beast, individual uniqueness that will not fit into the overall regional piece. That said, I think those are relatively minor and what we are looking for is consistency on a broad level, and it also helps to show that we are protecting state's rights.

What is the status of current emissions trading schemes (EU ETS, RGGI etc.)?

MW: To put it bluntly, the EU scheme is the major game in town. It is really a starting point. There is a long way to go but it is a very good start. The legislation was agreed to in record time, the scheme was put out, they proceeded with it and it is now having an impact. If nothing else, it raises the consciousness and the need to address the issue and that is very important. There are huge amounts of trade going on. Prices have just sky rocketed from $6/7 up to $17.9. There has also been a huge boost to the Clean Development Mechanism (CDM). People now know they can sell Certified Emission Reductions (CERs) into the EU scheme and developers are looking to get a better price for CERs.

PV: The Norwegians have got a scheme that is in the law, and they are now in discussions with the EU about linking their scheme with EU scheme (Norway is not an EU member state). We are aware that there is emissions trading developing in Canada, perhaps not before 2008, but under development. New Zealand has a kind of offset project credits, and there has been an interest expressed by the NZ Environment Minister to link their scheme with ours. In the US there are the Northeastern states and California who are developing their emissions trading schemes at a State level and similarly all the states of Australia have now committed themselves to develop an emissions trading scheme, notwithstanding the fact the Federal Government in Australia has not ratified the Kyoto Protocol. All the States have signed a Declaration of Intent to develop their scheme. Finally, Japan is a country that one must mention, crucially important in Kyoto - their environment ministry is also following what we are doing in Europe. There is a lot of interest, I can see, all over the world in the European scheme.

CJ: The RGGI is still in the development process. The agency heads from environmental, energy and utility regulators met last week and have asked the staff to do some additional technical work, particularly in the area of offsets and allocation schemes so that they can consider different recommendations. I don't think it's a question of years until RGGI is established, I really think it's a question of months. I would take it as a healthy step that the agency has indicated that they want to have a deliberative process and that they want to be involved.

How important is the success of the EU scheme?

PV: Crucially important in two respects. The success of the EU emissions trading is crucially important for the EU because it is the first time we have used this instrument and the public and many in government and business want to see that it actually delivers what it is supposed to deliver. There is, if you like, scepticism in some quarters that it is an instrument that actually works, that is to say that both achieves an environmental outcome and reduces the costs of fulfilling that environmental outcome.

On the international level, what implementing this scheme shows is that the EU is not just talking, talking, talking on climate change, it is actually doing something. If we manage to convince the international community that acting in this way makes good economic and environmental sense then we are showing what can be done, perhaps, on a wider scale, and in the longer term.

Do you think the EU scheme will become a de facto standard for emissions trading?

MW: I think there will be a real effort to make sure that any scheme that other countries develop will be capable of linking into the EU scheme, which we must remember is modelled on Kyoto. The challenge is getting co-ordinated markets so that eventually we get a cross-border trade that works.

PV: We didn't really put ourselves in this position of being a kind of pathfinder, but it happened because the US decided not to follow the Kyoto road - had they continued along that road I am sure they would have done emissions trading extremely well. But yes I think potentially we are talking about the EU scheme becoming the core of a wider international scheme. For linking to happen, of course, each jurisdiction has to feel comfortable with the environmental credentials of the other scheme that it is linking with.

CJ: In terms of other schemes such as RGGI linking with the EU ETS, as we understand the currency issue, as long as the states or regions have in place an enforceable cap which has certainty in terms of expectations, there is a measurement verification protocol, real reductions are occurring, and offsets are allowed under some sort of defined process, there is no reason why RGGI could not link up with other trading schemes - be they part of Kyoto or sub-regional schemes that may come out through Canada, or Australia for example. This is something that we are focused on at the moment. We currently need to ensure that we get the programme designed right, to achieve reductions as well as address the economic issues for affected stakeholders in the Northeast.

Is trading within Kyoto enough to realise the kind of emission reductions which are necessary long-term?

MW: Absolutely not. We need major technological breakthroughs and almost a new economic revolution if we are going to reach targets like a 60% reduction in CO2 emissions by 2050. Kyoto is a very important first step, and trading will deliver reductions, but a range of solutions to reduce global emissions is required. We've got to look at significant changes in the way we emit greenhouse emissions.

PV: What the EU is doing is something which is very much linked to its international commitment under the Kyoto Protocol, but it is not dependant upon it. We decided to use trading before the Kyoto Protocol entered into force and we would have done it anyway. It will be here beyond 2012 and we will be ready to adapt it as necessary so as to ensure it has a long term future. It contributes to whatever global efforts are made and whatever forum they are made in.

The views presented in the Viewpoint Series are not necessarily representative of the views of The Climate Group.